Rev. Rul. 61-181

Advice has been requested whether so-called `dividends' paid on Los Angeles Metropolitan Transit Authority Equipment Trust Certificates, Series A, are excludable from the gross income of the recipient as interest upon obligations of a political subdivision of a State.

The Los Angeles Metropolitan Transit Authority was created by the Los Angeles Metropolitan Transit Authority Act of 1957, Chapter 547 of the Statutes of California, 1957, as a public corporation of the State of California. The term `public corporation' as it is used in the Act means any county, city and county, city, town, municipal corporation, district of any kind or class, authority, or political subdivision of the State. The Authority, composed of seven members appointed by the Governor of California, was created to acquire or construct, establish, develop, and operate a mass rapid transit system for the county of Los Angeles. For this urpose it has the power of eminent domain, but has no power to levy taxes. Funds of the Authority may be deposited in such banks in the State of California as may be authorized to receive deposits of public funds and its funds may be invested only in accordance with the general laws of the State relating to investments of county funds.

Section 4.13 of the Act provides, in part, as follows:

* * * The authority may acquire rolling stock or other property under conditional sales contracts, leases, equipment trust certificates, or any other form of contracts, leases, equipment trust certificates, or any other form of contract or trust agreement. * * *

The Authority and a trust and savings association, as trustee, entered into an `Equipment Trust Agreement' by the terms of which the trustee issued trust certificates maturing serially over a period of eight years and bearing `dividends' at the rate of four and one-half percent per annum. The agreement provides, moreover, that the trustee will hold title to the equipment and lease the same to the Authority until the principal, dividends and trust expenses have been paid in full. In addition, it stipulates that payments of principal and dividends are payable solely from a portion of the revenues which is derived by the Authority from the operation of the transit system and paid over by the Authority to the trustee as rental for the use of the equipment. The payments characterized as `rent' are to be sufficient to pay, among other things, the necessary and reasonable expenses of the trust including compensation of the trustee, and the amounts of dividends appurtenant to the trust certificates as well as the principal thereof when and as the same shall become payable. At the termination of the lease and after all payments due or to become due from the Authority have been made to the trustee, any moneys remaining in the hands of the trustee after providing for all outstanding trust certificates and dividends and after payment of the expenses of the trustee, including its reasonable compensation, are to be paid to the Authority. Each certificate carries with it the Authority's guaranty for the payment of principal and dividends, but this obligation is limited to the revenues derived from operating the transit system of the Authority.

Section 103 of the Internal Revenue Code of 1954 provides, in part, as follows:

(a) * * * Gross income does not include interest on * * *

(1) the obligations of a State, * * * or a possession of the United States, or any political subdivision of any of the Foregoing, or of the District of Columbia; * * *

Section 1.103-1 of the Income Tax Regulations explains that the term `political subdivision' denotes `any division of the State, * * * or possession of the United States * * * to which has been delegated the right to exercise part of the sovereign power of the State * * *' and that obligations issued on behalf of such a political subdivision are considered the obligations of the political subdivision.

The Authority, a public corporation of the State of California, has been delegated certain sovereign powers of the State by the legislature of California to enable it to furnish mass transportation in Los Angeles County. These political powers have been limited only with reference to the purpose for which the Authority was created. Although the nominal issuer of the equipment trust certificates is the trustee, the obligations of the trustee are ministerial and the real obligor is the Authority. The trustee, moreover, is not liable for making any payments except out of the amounts received by it from the Authority as rent on the equipment. The guaranty of payment on each certificate is primarily the obligation of the Authority and not of the trustee.

It is clear from the foregoing that the certificates are issued on behalf of the Authority and constitute obligations of a political subdivision of the State. Although called `dividends,' the amounts received by the certificate holders are in reality interest, being computed as, and otherwise having all the characteristics of, interest.

Accordingly, it is held that dividends paid on Los Angeles Metropolitan Transit Authority Equipment Trust Certificates, Series A, are excludable from the gross income of the recipient as interest on the obligations of a political subdivision of a State within the meaning of section 103(a)(1) of the Code.